Canada: An Overview of Taxation of Trusts and Estates in Canada

The Canadian legal system is generally derived from English common law, and trust concepts are similar to those of the United Kingdom and a number of other English-speaking countries. Civil law in the province of Quebec is based on a civil code rather than common law, and trusts may be subject to different rules in that jurisdiction.

Types of Trusts

For Canadian tax purposes there are basically two kinds of trusts: testamentary and inter vivos. A testamentary trust is one that arises on and in consequence of an individual’s death. An inter vivos trust is any trust other than a testamentary trust.

Individuals commonly use inter vivos trusts as vehicles to hold property for the present and future needs of other members of their families, often as part of estate planning arrangements. Special rules apply to a spousal trust, which is a trust established for the exclusive benefit of the maker’s spouse. Spousal trusts may be either inter vivos or testamentary.

Taxation of Trusts

The taxable income of a testamentary trust attracts tax at the normal rates applicable to individuals. The tax payable by an inter vivos trust is calculated at a flat rate of approximately 50 percent (combined federal and provincial tax) of its taxable income.

Income of a trust resident in Canada that is paid or payable to a beneficiary is generally deductible in computing the taxable income of the trust and is included in the income of the beneficiary; therefore a trust may function as a conduit for tax purposes. However, designated income of an inter vivos trust (i.e. income from carrying on business in Canada, income from holding Canadian real estate, income from resource properties and timber resource properties, and gains realized on dispositions of taxable Canadian property) that is paid or payable to a beneficiary can, in certain cases (e.g. when the trust has non-resident beneficiaries), be subject to a special tax in the trust at 36 percent. This tax is deductible in computing the income of the trust and resident beneficiaries obtain credit for their share of tax. Non-resident beneficiaries do not obtain credit against basic income tax for their share of the tax and are also subject to a 25 percent withholding tax (15 percent if reduced by treaty) on distributions of designated trust income. This tax does not apply to testamentary and certain other trusts.

An unusual feature of Canadian tax law regarding trusts is that a trust is deemed to dispose of its assets every 21 years at their fair market values, subject to some exceptions. This deemed disposition could result in capital gains taxable to the trust itself. Upon the deemed disposition, the trust is also deemed to have reacquired the assets at the new values. The tax policy theory is that trusts should not be available as vehicles for undue deferment of capital gains taxes.

One potential result of the revaluation is that the trust could become liable to pay tax even though it did not receive proceeds from which to pay the tax. To ease the potential harshness of this situation, the tax may be paid in ten annual instalments with interest at prescribed rates.

Taxation of Beneficiaries

Income of a trust resident in Canada that is paid or payable to a beneficiary (and is therefore deducted in computing the taxable income of the trust) is included in the income of the beneficiary. Income taxed in a trust (other than designated income) may generally flow to beneficiaries free of tax. Dividend tax credits and foreign tax credits may flow through the trust to the beneficiary. Net taxable capital gains that are allocated to Canadian-resident individual beneficiaries can be eligible for the capital gains exemption.

Tax Treatment of Settlor/Grantor

The transfer of property to a trust by a settlor generally constitutes a disposition of that property at its fair market value and, accordingly, requires recognition for tax purposes of any resultant capital gain or loss. However, where the transfer is to a trust for the spouse of the settlor, and the trust meets certain conditions, no gain or loss will arise to the settlor as a consequence of the transfer, and the trust will be considered to have acquired the property for the settlor’s tax cost of such property.

Use of Trusts

Trusts are commonly used in estate planning arrangements for wealthy individuals to direct the distribution of their estate in such a manner and time as they consider appropriate. Trusts are also used to administer property on behalf of minors or others who are not regarded as capable of administering their own affairs. Trusts may also be used by immigrants to Canada in connection with their property held outside the country.

Trusts are not generally used for commercial enterprises in Canada, although advantages may exist in certain circumstances. Inter vivos trusts are frequently used as charitable trusts, unit trusts and mutual fund trusts.

Estates

For income tax purposes, an estate is taxed from inception as a testamentary trust on the death of the individual.

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The information provided herein is for general guidance on matters of interest only. The application and impact of laws, regulations and administrative practices can vary widely, based on the specific facts involved. In addition, laws, regulations and administrative practices are continually being revised. Accordingly, this information is not intended to constitute legal, accounting, tax, investment or other professional advice or service.

While every effort has been made to ensure the information provided herein is accurate and timely, no decision should be made or action taken on the basis of this information without first consulting a PricewaterhouseCoopers LLP professional. Should you have any questions concerning the information provided herein or require specific advice, please contact your PricewaterhouseCoopers LLP advisor.

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